Value Chain

Strategy

— Vitaly, could you tell me about Gazprom Neft Trading’s development strategy.

— It is based on the strategy of our parent company (Gazprom Neft). We are planning active business development abroad, the extension of operational areas and business sectors. Gazprom Neft Trading is now the channel for a major part of Gazprom Neft Group’s crude oil exports and petroleum product deliveries. Our strategy is particularly aimed at growth in the international markets through the value chain of crude oil and petroleum products. To achieve this, Gazprom Neft Trading enters the target regional markets.

— How exactly do you do this?

— When we enter each new market, we start with understanding the needs of our potential partners. The clients are almost always refineries and wholesale fuel companies. If the business goes well, then we identify the assets which can add value to Gazprom Neft’s crude oil and petroleum products in the foreign markets. We pay special attention to interaction with other Gazprom Neft companies because synergy enhances financial and business efficiency.

— What is the scale of the company’s operations?

— From 2008 to the first half of 2011, sales in foreign markets totaled around 88 million tons of crude oil and petroleum products. Today, Gazprom Neft is ranked third among the Russian companies carrying out foreign supplies of diesel fuel and it is fifth in exports of crude oil and fuel oil export.

— What progress has been made to date?

— We have significantly extended our export geography: Gazprom Neft Trading supplied crude oil and petroleum products to North-Western and Central Europe as well as to the main players in the Mediterranean market and to refineries in the Asia-Pacific Region (APR).

The crude oil was sent mainly to Europe — 51.5 million tons. Another 3.3 million tons of hydrocarbons are exported to the Asia-Pacific Region. As for petroleum products, 33 million tons were sold in Europe, Asia-Pacific Region, Africa, and North America. Gazprom Neft Trading is also one of the major suppliers to NIS refineries (Naftna Industrija Srbije a. d.), a Gazprom Neft subsidiary in Serbia.

Ways of Delivery

— What are the principal means of export used by Gazprom Neft Trading?

— Crude oil and petroleum products are mainly exported by oil tankers. The main port for the crude oil exportation is Primorsk as it is a perfect gateway to access the markets of North-West Europe. Over the last three and a half years, we have exported a total of 24 million tons of oil through that port.

Our clients in the Mediterranean have received 13.2 million tons of hydrocarbons through the Black Sea ports, including 8 million tons of the Urals brand, which was shipped from Novorossiysk, and 5.2 million tons of Siberian Light from Tuapse. Owing to the completion of ESPO-1, early in 2010 we opened a new export direction to South-Eastern Asia — one of the most promising global markets. We take a pro-active approach in that region and supply crude to refineries in Korea, China, and Japan. Since this sales channel was launched, Gazprom Neft Trading has delivered 3.3 million tons of oil using the new trunk line.

In addition to this, export oil is partially delivered by a pipeline. The key export pipeline for us is the Druzhba pipeline. It supplies crude oil to the countries in Eastern and Central Europe. From 2008 to the first half of 2011, Gazprom Neft Trading delivered around 11.9 million tons of oil using this route. We are the only exporter selling 100% of the crude oil transported by the Druzhba pipeline to end users.

Regarding petroleum products export, low-sulfur diesel fuel (ULSD) has the highest demand in Europe. We ship 10 ppm sulphur diesel from the Port of Primorsk. Our three-and-a-half-year export amounts totaled 3.9 million tons. High-sulfur diesel resources are marketed in North-Western Europe being shipped through the Baltic ports, and in the South of Europe being shipped through Novorossiysk — the export amounts for the same three and a half years totaled 11.3 million tons.

Fuel oil is supplied to the Northwest European markets via the Russian Port of Ust-Luga and the Baltic Ports of Ventspils, Klaipeda, and Tallinn. Murmansk is another fuel oil export gateway. Foreign supplies of naphtha (this product is in demand with refineries and petrochemical companies in North-West Europe) amounted to 5.6 million tons.

Highlights

— What terms of delivery do you offer?

— Most of the crude oil and petroleum product sales have the long-range basis of delivery — CIF (Cost, Insurance and Freight), CFR (Cost and Freight), DES (Delivered ex Ship), ITT (In Tank Transfer), FOB (Free On Board) and other similar terms. Each year, our Logistics and Transportation Department deals with the freighting and delivery of over 10 million tons of crude oil and products.

— In your opinion, which recent events have been momentous for your company?

— First of all, we are starting business in the APR. We have established contacts with all the leading companies owning refining facilities in the region. We freight cargo ships for the purpose of shipping oil from the Port of Kozmino, and this enables us to export crude directly to the consumption market based on CFR terms of delivery. Other Russian suppliers ship oil from Kozmino according with FOB terms of delivery.

We have also launched diesel wholesale trading in the Northwest European markets, which is a real step forward in creating the added value chain for petroleum products. We hold fuel storage tanks on lease in the region and sell our products to large and small wholesalers, enlarging our presence in the target markets.

Furthermore, we try to minimize the company’s price risks through hedging transactions. Derivative instruments are the integral part of international trading. Since the beginning of 2010, Gazprom Neft Trading hedges some oil resources to minimize price risks. Diesel fuel price hedging is implemented through future contracts. The combination of hedging and product storage derives additional profit from the market structure.

The next step will be business development on the African continent. Oil from Angola and North Africa enables supplies to the Mediterranean at a competitive price due to relatively cheap logistics. We have also continued to strengthen our level of cooperation with NIS in the field of raw material supplies to its refineries. We have been dealing with NIS since 2009 and plan to increase our cooperation.

We will meet our targets for performance growth by means of wholesale trade optimization, which involves selling the parent company’s products coupled with purchasing diesel fuel in the market. We are going to focus on this for the time being. The company’s experience and esteemed practices will facilitate our activity in the new markets.

There are other interesting business solutions. For example, this year Turkey adopted European environmental standards, which require using low-sulfur diesel — 10 ppm at the most — to fill up vehicles. A change in specifications from the consumer markets is always a challenge for exporters. So, we had to sell high-sulfur diesel fuel through Novorossiysk and this required new business solutions from us. Our success in expanding sales in Asia is one of Gazprom Neft Trading’s ongoing focuses, an important and very promising process which requires market research, negotiations with potential clients, pricing flexibility, analyzing logistics, and much more besides.

Future Prospects

— What are Gazprom Neft Trading’s plans for now until 2015?

— Our current trading plans are aimed at setting up the basis for future success in oil sales from fields in the Middle East and Latin America. Also, according to Gazprom Neft’s international business development strategy, in addition to the company’s export resources, we aim to increase the purchase of oil from third parties for direct supplies both to internal companies abroad and to our target clients — leading refineries in Europe and the APR.

I would like to remind that in a few years from now all the Gazprom Neft refineries will be upgraded to meet 10 ppm diesel specification, which complies with Euro-5 standard. Correspondingly, our export of ULSD is expected to double by 2015. Due to the growing dieselization of the Northwest European countries, we want to introduce Gazprom Neft’s diesel products into the import markets by means of progressive movement forward along the value chain.

— Do you plan to develop new supply channels and open up new lines of business?

— Europe and Asia will remain Gazprom Neft Trading’s main markets for crude oil; Europe, Africa and APR for diesel fuel and naphtha; Europe and the Asia-Pacific Region for fuel oil. However, the development of Gazprom Neft’s production projects will determine new sources of export — from Latin America, Near East, and Africa. I would also like to point out that our parent company participates in the development of oil and gas resources in Cuba, Venezuela, Iraq and Equatorial Guinea. The hydrocarbons produced will go to North America, Europe, and Asia.

The added value chain strategy forces the necessity of finding new export directions with deliveries aimed at the end user markets in all the regions. That’s why we are working on fuel oil and naphtha transportation options to Asia. The major fuel oil importers in the region are China, Vietnam and Singapore. The highest demand for naphtha is observed in the markets in China, Taiwan, Japan and South Korea.

Taking into account the world best practices, Gazprom Neft Trading monitors the fuel and alternative energy markets in general.

Key Trends

— Coal, oil, and gas currently account for about 80% of energy sources in the world — this disposition will hardly change over the next few years, at least until 2020. As far as we know, the countries with the major oil reserves are Russia, the Middle East, Latin America and Africa, so Europe will depend on imported oil more and more. The APR countries will also be shorten in their domestic energy resources. Until 2020, this region is expected to increase its consumption of crude oil and petroleum products. At the same time, North America could activate their projects, which will enhance oil production.

The profitability of refining is step by step recovering from the global financial recession. However, the refining output in Europe keeps on falling. There are two reasons. Firstly, refineries with low complexity levels are being shut down as often it is more economically viable for their owners to sell them or diverse them into fuel storage terminals. Secondly, international vertically integrated oil companies are withdrawing from Downstream to focus on exploration and production. As a result, the market is evolving — the assets on sale open up possibilities for new players — mainly Asian or Russian companies.

Europe dieselization is on-going — more and more personal vehicles are beginning to use diesel fuel. The region’s dependence on the import of diesel fuel is growing. And there are some processes in Russia which are helping to set the trends: re-equipment and upgrade of refineries, processing depth increase, production diversification for foreign assets. In the Middle East, they are constructing new refineries, which will eventually increase the pressure towards their competitors.

In general, the demand for motor fuel in the developed economies will stabilize, although it will be on the increase in the emerging markets; for example, Southeast Asia has only just started developing a vehicle fleet, but it will eventually turn into a huge consumer market.